The G-20 Economic Summit: More Symbolic than Substantive?Published: November 12, 2008 in Knowledge@Wharton
It seems sensible: Bring leaders of the 20 largest economies together to discuss a coordinated plan for dealing with the world financial crisis. In October, when U.S. President George Bush called for the November 15 G-20 Economic Summit in Washington, D.C., some commentators likened it to the momentous Bretton Woods meeting of 1944, which set exchange-rate rules and established the World Bank and International Monetary Fund.
But there has been little news coverage of the upcoming gathering since then, and it seems as if no one now expects the meeting to achieve anything sweeping. "I think it will be difficult to accomplish much given that they've had little time to prepare for this," says Mark Zandi, chief economist and co-founder of Moody's Economy.com. "It is more symbolic than substantive."
"The whole idea of a summit at this point is premature and potentially dangerous," adds Wharton finance professor Richard J. Herring, concerned that world leaders, eager to look like they are doing something, could move too fast to set up new policies and regulations. "Our understanding of precisely what went wrong and how it should be fixed is so incomplete."
With Bush leaving office in January, this is "an awkward time in the U.S. political cycle" because the president cannot make long-term commitments, noted Wharton finance professor Richard Marston. Indeed, many experts have cited Bush's lame duck status in downplaying expectations for the summit. President-elect Barack Obama declined Bush's invitation to attend and has scheduled his own talks with world leaders.
"I hope that Obama stays far away from [the summit] and that Bush is completely non-committal," Herring says. The Europeans, he added, "have plenty to fix in the [European Union] without reinventing the world financial order."
The White House has said it hopes the summit leaders will establish some "general principles" for dealing with financial issues rather than try to establish firm regulations. Among the most useful principles they could adopt, says Zandi, would be an agreement to resist protectionist impulses. "One thing is ... to assure everyone that countries are not going to begin erecting barriers to trade and investment. I think that's a significant concern. As times get tough, there is going to be tremendous political pressure for countries to get more protective, and that would be very counter-productive.... It was the rise of protectionism that contributed to the Great Depression."
According to Zandi, the summit attendees should signal that their central banks will continue to coordinate policy, as they have in cutting interest rates recently. Countries should also work together to prevent wild gyrations in currency exchange rates and to signal a willingness to spend money to stimulate their economies, he says. "Finally, it might be helpful if they could say collectively that if any one of them gets into trouble, they would all be there to help."
While summit leaders may look for common ground, most would probably prefer to focus on their individual financial issues, says Marston. "I suspect that each country is going to grapple with its own regulatory structure for the next couple of years. They will confer -- especially the central banks -- as they always do. But I am not at all sure the U.S. and the Euro area will try to coordinate policies."
Still, he notes, there are some areas that may demand international policy agreement eventually. A key one: How to deal with credit-default swaps, the unregulated instruments at the heart of the crisis. These work as a kind of insurance, with the buyer paying fees and receiving a big payment if a specific event occurs. The owner of a corporate bond, for example, can buy a swap as insurance against the risk that the company defaults on its bond payments.
Some experts estimate that more than $60 trillion in credit-default swaps have been written. But the market is very opaque, and many banks and other companies are fearful of doing business with one another because they worry that big, unknown swap liabilities could cause counterparties to fail to live up to financial obligations.
A number of economists and business leaders say that such instruments should be standardized and traded on a central exchange like stocks, options or futures contracts. Some also suggest that firms which sell credit-default swaps be required to carry cash reserves to make good on obligations. There is no such requirement today. Adds Marston: "There are a few areas, like swaps, where the approach to regulation could be multinational."
There will be a limit to what can be accomplished at the summit itself, however. "We're probably going to end up with regulated exchanges on things like [credit-default swaps], but I doubt they will talk about that at the [summit]," says Wharton finance professor Franklin Allen.
Domestic Concerns First
Before countries can establish new international financial regulations, they need to deal with some domestic issues, according to Wharton finance professor Marshall Blume. "The first thing that needs to be done in the U.S. is to rationalize our regulation -- before we can internationalize anything."
Investors and speculators, for example, can bet on a company by buying its stock, purchasing options on that stock or taking on swaps contracts that will rise or fall in value as the company's fortunes change. Stocks are regulated by the Securities and Exchange Commission and options by the Commodity Futures Trading Commission, while swaps are unregulated. Yet trading in one of these instruments can influence values in the others.
While some experts have suggested swaps be regulated the way insurance policies are, Allen notes that in the U.S., insurance regulation is mainly left to the 50 states. There might need to be some superseding federal regulation before the U.S. could participate in an international regulatory regime for swaps, he says. "It would be almost impossible to coordinate international regulation with 50 states."
A major difficulty with any international agreement is finding ways to prevent participants from shopping around for the country offering the most agreeable rules, he adds. Currently, for example, companies look at accounting and other rules before deciding where to list their stock -- in New York, London or elsewhere. Some countries may object to new international standards that would make it harder for them to compete for securities listings and other business, and many countries would refuse to bow to any international authority, Blume predicts. "As a political matter, I can't see the U.S. giving up any regulatory authority to an international body. But we can coordinate with international bodies."
Meaningful coordination is already occurring even without an economic summit or new regulatory system, Blume notes. Many central banks have cut interest rates, pumped money into their banking systems and either announced economic stimulus plans, as China has, or started talking about them seriously, as in the U.S. "They seem to be somewhat coordinated now, and that seems to be a good thing. We just have to make sure that these channels of cooperation remain open."
Too Much Market Freedom?
Some coordination will need to continue for the long term, not just for the duration of this crisis, Allen argues, pointing to market volatility sparked by rapid changes in exchange rates and vast differences in interest rates from country to country.
While it is not clear that there should be a rigid set of international financial regulations, some updating is clearly needed, Allen maintains. He notes that the International Monetary Fund and World Bank are dominated by Europeans and Americans. "They need to involve the Asians more," he says, pointing out that China and Japan have vast resources that could be contributed to IMF and World Bank programs.
While it may be too early to address international banking regulations such as Basil II Accords, these should eventually be reexamined with an eye toward controlling the risk-taking that caused problems for both the investment and commercial banks, Allen adds. "We need to start from scratch."
Indeed, he predicts an international reexamination of the most fundamental kind: How free should free markets be? "We're stuck in this ideology of the past 20 years, which is that markets work and you should leave things to the markets," Allen says, arguing that the current crisis shows there is such a thing as too much market freedom.
This fall, a number of governments have taken stakes in banks they have bailed out, and they have generally described these moves as temporary. But banking may work better with some permanent form of public-private partnership, with government guarantees shoring up confidence in the banking system, Allen suggests.
But such far-reaching issues are for the future, not the November 15 summit, he says. "People really haven't started thinking about this at all."